RePEc: Research Papers in Economics
Research Papers in Economics is a collaborative effort of hundreds of volunteers in many countries to enhance the dissemination of research in economics.
NCER Working Paper Series
2012
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#88Download full text
- JEL-Codes:
- C22; G00
- Keywords:
- Implied volatility, VIX, hedging, semi-parametric, forecasting
Forecasting increases in the VIX: A time-varying long volatility hedge for equities
Since the introduction of volatility derivatives, there has been growing interest in option implied volatility (IV). Many studies have examined informational content, and or forecast accuracy of IV, however there is relatively less work on directly modeling and forecasting IV. This paper uses a semi-parametric forecasting approaching to implement a time varying long volatility hedge to combine with a long equity position. It is found that such a equity-volatility combination improves the risk-return characteristics of a simple long equity position which is particularly successful during periods of market turmoil.
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#87Download full text
- JEL-Codes:
- C22;C52
- Keywords:
- stochastic volatility, parameter estimation, maximum likelihood, particle filter
Estimating the Parameters of Stochastic Volatility Models using Option Price Data
This paper describes a maximum likelihood method for estimating the parameters of Heston's model of stochastic volatility using data on an underlying market index and the prices of options written on that index. Parameters of the physical measure (associated with the index) and the parameters of the risk-neutral measure (associated with the options) are identified including the equity and volatility risk premia. The estimation is implemented using a particle filter. The computational load of this estimation method, which previously has been prohibitive, is managed by the effective use of parallel computing using Graphical Processing Units. A byproduct of this focus on easing the computational burden is the development of a simplification of the closed-form approximation used to price European options in Heston's model. The efficacy of the filter is demonstrated under simulation and an empirical investigation of the fit of the model to the S&P 500 Index is undertaken. All the parameters of the model are reliably estimated and, in contrast to previous work, the volatility premium is well estimated and found to be significant.
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#86Download full text
- JEL-Codes:
- C21; L13
- Keywords:
- Retail Gasoline Pricing, Vertical Restraints, Shop-a-Docket Discount Scheme, Spatial Econometrics, Australia
A Spatial Econometric Analysis of the Effect of Vertical Restraints and Branding on Retail Gasoline Pricing
This paper builds an econometric model of retail gas competition to explain the pricing decisions of retail outlets in terms of vertical management structures, input costs and the characteristics of the local market they operate within. The model is estimated using price data from retail outlets from the South-Eastern Queensland region in Australia, but the generic nature of the model means that the results will be of general interest. The results indicate that when the cost of crude oil and demographic variations across different localities are accounted for, branding (i.e. whether the retail outlet is affiliated with one of the major brand distributers - Shell, Caltex, Mobil or BP) has a statistically significant positive effect on prices at nearby retail outlets. Conversely, the presence of an independent (non-branded) retailer within a locality has the effect of lowering retail prices. Furthermore, the results of this research show that service stations participating in discount coupon schemes with the two major retail supermarket chains have the effect of largely off-setting the price increase derived from branding affiliation. While, branding effects are not fully cancelled out, the overall effect is that prices are still higher than if branding did not occur.
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#85Download full text
- JEL-Codes:
- C22; G00
- Keywords:
- Multivariate volatility, portfolio allocation, forecast evaluation, model selection, model confidence set
Selecting forecasting models for portfolio allocation
Techniques for evaluating and selecting multivariate volatility forecasts are not yet as well understood as their univariate counterparts. This paper considers the ability of different loss functions to discriminate between a competing set of forecasting models which are subsequently applied in a portfolio allocation context. It is found that a likelihood based loss function outperforms it competitors including those based on the given portfolio application. This result indicates that the particular application of forecasts is not necessarily the most effective approach under which to select models.
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#84Download full text
- JEL-Codes:
- I1;J2;O1,O2
- Keywords:
- Child labour, Health, Human capital, Income inequality, Multiple equilibria
Why does child labour persist with declining poverty?
Uneven success of poverty-based approaches calls for a re-think of the causes behind persistent child labour in many developing societies. We develop a theoretical model to highlight the role of income inequality as a channel of persistence. The interplay between income inequality and investments in human capital gives rise to a non-convergent dynamic path of income distribution characterised by clustering of steady state relative incomes around local poles. The child labour trap thus generated is shown to preserve itself despite rising per capita income. In this context, we demonstrate that redistributive policies, such as public provision of education can alleviate the trap, while a ceteris paribus ban on child labour is likely to aggravate it.
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#83Download full text
- JEL-Codes:
- D03;D81;C93
- Keywords:
- Decision under risk, large losses, natural experiment
Variation in Risk Seeking Behavior in a Natural Experiment on Large Losses Induced by a Natural Disaster
This study explores people's risk attitudes after having suffered large real-world losses following a natural disaster. Using the margins of the 2011 Australian floods (Brisbane) as a natural experimental setting, we find that homeowners who were victims of the floods and face large losses in property values are 50% more likely to opt for a risky gamble - a scratch card giving a small chance of a large gain ($500,000) - than for a sure amount of comparable value ($10). This finding is consistent with prospect theory predictions of the adoption of a risk-seeking attitude after a loss.
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#82Download full text
- JEL-Codes:
- C14; C53.
- Keywords:
- Electricity Prices, Prices Spikes, Semi-parametric, Multivariate Kernel
Semi-parametric forecasting of Spikes in Electricity Prices
The occurrence of extreme movements in the spot price of electricity represent a significant source of risk to retailers. Electricity markets are often structured so as to allow retailers to purchase at an unregulated spot price but then sell to consumers at a heavily regulated price. As such, the ability to forecast price spikes is an important aspect of effective risk management. A range of approaches have been considered with respect to modelling electricity prices, including predicting the trajectory of spot prices, as well as more recently, focusing of the prediction of spikes specifically. These models however, have relied on time series approaches which typically use restrictive decay schemes placing greater weight on more recent observations. This paper develops an alternative, semi-parametric method for forecasting that does not rely on this convention. In this approach, a forecast is a weighted average of historical price data, with the greatest weight given to periods that exhibit similar market conditions to the time at which the forecast is being formed. Weighting is determined by comparing short-term trends in electricity price spike occurrences across time, including other relevant factors such as load, by means of a multivariate kernel scheme. It is found that the semi-parametric method produces forecasts that are more accurate than the previously identified best approach for a short forecast horizon.
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#81Download full text
- JEL-Codes:
- C91, L15, D82, D40
- Keywords:
- Credence Goods, Experts, Pricing,
The Good, the Bad and the Naive: Do fair prices signal good types or do they induce good behaviour?
Evidence on behavior of experts in credence goods markets raises an important causality issue: Do "fair prices" induce "good behavior", or do "good experts" post "fair prices"? To answer this question we propose and test a model with three seller types: "the good" choose fair prices and behave consumer-friendly; "the bad" mimic the good types' price-setting, but cheat on quality; and "the naive" fall victim to a projection bias that all sellers behave like the bad types. OLS, sample selection and fixed effects regressions support the model's predictions and show that causality goes from good experts to fair prices.
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#80Download full text
- JEL-Codes:
- C22;G11;G17
- Keywords:
- Volatility, multivariate GARCH, portfolio allocation
Forecasting multivariate volatility in larger dimensions: some practical issues
The importance of covariance modelling has long been recognised in the field of portfolio management and large dimensional multivariate problems are increasingly becoming the focus of research. This paper provides a straightforward and commonsense approach toward investigating whether simpler moving average based correlation forecasting methods have equal predictive accuracy as their more complex multivariate GARCH counterparts for large dimensional problems. We find simpler forecasting techniques do provide equal (and often superior) predictive accuracy in a minimum variance sense. A portfolio allocation problem is used to compare forecasting methods. The global minimum variance portfolio and Model Confidence Set (Hansen, Lunde, and Nason (2003)) are used to compare methods, whilst portfolio weight stability and computational time are also considered.
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#79Download full text
- JEL-Codes:
- D82;H50;H61
- Keywords:
- Electoral control, Fiscal restraints, Credence goods
Expert Politicians, Electoral Control, and Fiscal Restraints
Fiscal restraints have been argued to force today's governments to internalize the externalities that result from extensive borrowing on future electorates and governments as well as on other countries by causing fiscal instability. In this article we provide an alternative argument for fiscal restraints which is based on an agency perspective on government. A budget maximizing politician is better informed than the electorate about the necessary spending to ensure the states ability to provide services for the economy. In this respect, the politician is an expert in the meaning of the credence good literature. The electorate, being able to observe the budget but not the necessary level of spending, will reelect a government if its budget does not exceed a critical level. A fiscal restraint limits the maximum spending a government will choose if the reelection level is not sufficient to ensure the state's ability to provide services to the economy. We determine when such a fiscal restraint improves voter welfare and discuss the role of the opposition in situations where very high levels of spending are required.
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#78
μ-σ Games
Risk aversion in game theory is usually modelled using expected utility, which has been critized early on leading to an extensive literature on generalized expected utility. In this paper we are first to apply μ-σ theory to the analysis of (static) games.
μ-σ theory is widely accepted in the finance literature, using it allows us to study the effect on uncertainty endogenous to the game, i.e. mixed equilibria. In particular, we look at the case of linear μ-σ utility functions and determine the best response strategy. In the case of 2x2- and NxM-games we are able to characterize all mixed equilibria.